11.433j / 15.021j real estate economics - mit - massachusetts

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11.433J / 15.021J Real Estate EconomicsFall 2008

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MIT Center for Real Estate

Week 1: Introduction• The space versus asset market: 4 Quadrant

math.• Real Estate Micro Economics: Hedonics,

Location, density, government regulations.• Real Estate Macro Economics: timing

behavior (search, moving, contracts), cycles, regional growth.


The Role of Real Estate in the Economy

• Construction [6% of GDP]• Service flow, “Shelter”, rent plus imputed

rent [20% + of GDP]• Assets [55-60% of total national wealth]• Land? Not part of GDP (we don’t make

land), but it is part of wealth.• Accounting, measurement difficulties [book

versus market value]


$ (in Billions) % of GDP

Private Construction 650

Public Construction 210 2.0

Total new construction 861

Total GDP: 10,624

Buildings

Buildings

IndustrialHousing and development

Other

Nonbuilding constructionPublic utilitiesAll other

547

Nonbuilding constructionInfrastructureAll other

102

26

94108

9711

Residential buildingsNonresidential buildings

422167

IndustrialOfficeHotels/MotelsOther commercialAll other nonresidential

1738105646

6.1

8.1

100.0

0.50.1

1.0

0.00.1

0.91.00.90.1

4.01.60.20.40.10.50.4

Value of New Construction Put in Place, 2002

Source: Current Construction Reports, Series C30, U.S. Census Bureau. Gross Domestic Product from Economic Report of the President, 2004

Figure by MIT OpenCourseWare.


The Value of US Real Estate Assets (1990)

$, in billions % of Total

Residential 6,122 69.8

Single Family Homes 5,419 61.7

Multifamily 552 6.3

Condominiums/Coops 96 1.1

Mobile Homes 55 0.6

Nonresidential 2,655 30.2

Retail 1,115 12.7

Office 1,009 11.5

Manufacturing 308 3.5

Warehouse 223 2.5

Total U.S. Real Estate 8,777 100.0

Adapted from DiPasquale and Wheaton (1996)

MIT Center for Real EstateU.S. Real Estate

Ownership, 1990All Real Estate Residential Only Nonresidential Only

$, in billions % $, in billions % $, in billions %

Individuals 5,088 58.0 5,071 82.8 17 0.6

Corporations 1,699 19.4 66 1.1 1,633 61.5

Partnerships 1,011 11.5 673 11.0 338 12.7

Nonprofits 411 4.7 104 1.7 307 11.6

Government 234 2.6 173 2.8 61 2.3

Institutional Investors 128 1.5 14 0.2 114 4.3

Financial Institutions 114 1.3 13 0.2 101 3.8

Other (Including Foreign 92 1.0 8 0.1 84 3.2

Total: 8,777 100.0 6,122 100.0 2,655 100.0

% of All Real Estate 100.0 69.8 30.2

Adapted from DiPasquale and Wheaton (1996)

Exhibit 2-3: The DiPasquale-Wheaton 4-Quadrant Diagram…

Rent $

Stock (SF)Price $

Construction (SF)

Space Market:Stock Adjustment

Asset Market:Construction

Space Market:Rent Determination

Asset Market:Valuation

Q*

R*

P*

C*

D

D


Systems of Economic Equations• Parameters: Constants that reflect underlying

behavior, α, β, δ.• Endogenous variables: values that the model

“determines: C, S, R, P.• Exogenous variables: values that determine the

model’s variables, but which the models variables in turn do not influence: i, E.

• Equilibrium: Solution to the endogenous variables given exogenous values and parameters.

• Comparative Statics: How changes in exogenous variables change equilibrium endogenous ones.


1st quadrant1). Office Demand = α1ER-β1

E= office employmentR = rent per square footβ1 = rental elasticity of demand, %change

in sqft per worker/% change in rent]α1 = sqft / E when R=$1

2). Demand = Stock = S3). Hence: R = (S/α1E)–1/ β1 {downward sloping schedule}


2nd and 3rd Quadrants4). P = R/i

i = all inclusive cap rate5). Office Construction rate:

C/S = α2Pβ2

P = Asset Price per square foot[“Q” theory?]β2 = Price elasticity of supply:[% change in construction rate/% change in price]


4th Quadrant6). Replacement version (graph):

E= fixed, δS = building lossesΔS/S = C/S - δ [Construction rate – loss

rate equals net additions = 0 in equilibrium]7). Steady Demand growth version:

ΔE/E = δ, no losses Hence: ΔS/S - ΔE/E = C/S - δ[what happens to S/E if C/S >< δ ?]

MIT Center for Real EstateRent $

Stock (SF)Price $

Construction (SF)





Q*

R*

P*

C*

D0D1

Effect of Effect of Demand GrowthDemand Growth in Space Market: More in Space Market: More JobsJobs


Stock (SF)Price $

Construction (SF)



Space Market:Rent DeterminationAsset Market:

Valuation

Q*

R*

P*

C*

D0D1

Effect of Demand Growth in Space Market:Effect of Demand Growth in Space Market:

First phaseFirst phase……

Excess (negative) vacancy…

Doesn’t form a rectangle.


Stock (SF)Price $

Construction (SF)





Q*

R*

P*

C*

D0D1

R1

P1

Effect of Demand Growth in Space Market: Effect of Demand Growth in Space Market:

2nd phase2nd phase……

Can this be a long-run equilibrium result?…

Doesn’t form a rectangle.

Rents spike and get rid of excess (negative) vacancy


Stock (SF)Price $

Construction (SF)





Q*

R*

P*

C*

D0D1

R1

P1

Effect of Demand Growth in Space Market: Effect of Demand Growth in Space Market: LR EquilibriumLR Equilibrium……

R**

P**

C**

Q**

In long run equilibrium new supply tempers initial rent spike


Stock (SF)Price $

Construction (SF)





Q*

R*

P*

C*

11% CAP

8%CAP

D0

D1

P1

P**

R**

Q**

C**

SR

LR

Effect of Demand Growth in Effect of Demand Growth in AssetAsset MarketMarket……


Using the 4-Quadrant Model to assess the impact of other changes.

• What happens if Construction costs rise or the supply schedule shifts?

• Suppose depreciation speeds up (functional obsolescence dictates shorter life spans of buildings)?

• How to interpret owner occupied space (e.g. Single Family Housing)?

• EXERCISE #1.


Current Issues: using the diagram• Zero (or negative) population and labor force

growth in: Japan, Germany, Italy, Spain…? • Increasing use of the Internet for retail

shopping? • Expanded availability of (subprime) mortgage

credit to households previously ineligible? • Continued global saving glut from growth in

Asia – where savings rates are 20%+


Real Estate Macro-economics: Real Estate Cycles and Secular Trends• What are real estate cycles? Truly independent

oscillations or just reactions to the economy.• Cycles vary with Property type. • Cycles are related to broader capital markets. • Secular trend: growth rates of the stock

(construction) slow as economy matures. • Secular trend: Prices adjusted for inflation rise

over time?


Sources: BLS, BOC, TWR.

-3

-2

-1

0

1

2

3

4

5

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

Year

-ove

r-ye

ar c

hang

e in

tota

l em

ploy

men

t, m

illio

ns

0.0

0.4

0.8

1.2

1.6

2.0

2.4

2.8

3.2

Tota

l hou

sing

sta

rts,

mill

ions

of u

nits

New Jobs (L) Total Housing Starts (R)

Prefect Historic correlation between economic recessions and Housing Production – except for the last 5 years


Housing and U.S. Job Growth

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

1969

Q319

71Q1

1972

Q319

74Q1

1975

Q319

77Q1

1978

Q319

80Q1

1981

Q319

83Q1

1984

Q319

86Q1

1987

Q319

89Q1

1990

Q319

92Q1

1993

Q319

95Q1

1996

Q319

98Q1

1999

Q320

01Q1

2002

Q320

04Q1

2005

Q320

07Q1

job

grow

th

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

real

med

ian

hom

e pr

ices

Job Grow th Real Median Home Price Grow th (lagged)

based on 4-qtr moving averages

Prefect Historic correlation between economic recessions and Housing Prices – except for the last 5 years


With offices, building booms follow rents. The booms then generate falling rents = endogenous cycle?

140

120

100

80

60

40

20

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

0

15

10

5

0

-5

-10

Office construction and rent growth (TWR sum of markets)

Completions - Historical average

Forecast

Completions in msf (L) TWR rent inflation in % (R)



-2.00%

0.00%

2.00%

4.00%

6.00%

8.00%

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

20.00

22.00

24.00

26.00

28.00

30.00

32.00

34.00

Total Employment Growth (L) Real Rent (R) Completion Rate (L)

$ Per Sqft

National Office MarketCompletions Rate vs. Real Rent

Forecast


Historically: Rents over the “cycle”mean revert around Development costs

100

110

120

130

140

150

160

170

180

190

200

1988

Q119

89Q1

1990

Q119

91Q1

1992

Q119

93Q1

1994

Q119

95Q1

1996

Q119

97Q1

1998

Q119

99Q1

2000

Q120

01Q1

2002

Q120

03Q1

2004

Q120

05Q1

2006

Q120

07Q1

2008

Q1

15

17

19

21

23

25

27

29

31

PPI: Construction Materials and Components TWR Rent Index

PPI: Construction TWR Rent Index

Source: BLS, TWR Office Outlook XL, Summer 2008


-2%0%2%4%6%8%

10%12%14%16%18%

1901 1910 1919 1928 1937 1946 1955 1964 1973 1982 1991 2000

Downtown Suburban

Construction as % of Stock

Over the long run there also are:little cycles and Big cycles Broken

Ground Projects


Index of Historic Housing Prices in Amsterdam (Real Guilders)

g y ( g )

0

50

100

150

200

250

300

350

400

16281638164816581668167816881698170817181728173817481758176817781788179818081818182818381848185818681878188818981908191819281938194819581968

Year

Pric

e In

dex


CPI Apartment Rent Indices for Selected "traditional" Cities: 1918-1999 (constant $)

0

50

100

150

200

250

300

350

400

1918

1921

1924

1927

1930

1933

1936

1939

1942

1945

1948

1951

1954

1957

1960

1963

1966

1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

Year

Apa

rtm

ent R

ent

NEW YORK BOSTON CHICAGO WASHINGTON D. C. SANFRANCISCO


Long run Appreciation? Just inflation (3.5%) for 100 years in NYC, but lots of decade risk

Price Index 1899 = 1.0 constant dollars/square ft.

Source: MIT 2002 Thesis

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1899 1909 1919 1929 1939 1949 1959 1969 1979 1989 1999


Real Estate Micro-economics: Cities and Land Markets

• No two properties are identical [complete product differentiation]

• Properties are close if not perfect substitutes for each other – at some price differential.

• Price differentials are extremely large, and very predictable.

• Price differentials tend to be stable over time: local neighborhoods do not have independent cyclic movements.

MIT Center for Real EstateHouse prices reflect both unit characteristics and

location attributes

17.19

8.525.71 In(sqrt)

In(s

ale)

9.34

Sale amount against square feet, Phoenix



Repeat-Sale House price indices (CSW) for 15 submarkets within the greater Boston CMSA: 1982-2002 (current $)

House Price Indexes, Eastern Massachusetts, by City/Town Location

0

50

100

150

200

250

300

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

Year

Pric

e In

dex

(199

0=10

0)

BostonSoutheastW estern 1Far North Shore495 North95 South95 NorthW estern 2Lowell Area495 W estNorth ShoreSouth ShoreW orcester AreaCam bridge AreaNorth Central


Median Home Price, Thousands ($ 2002.4)

Sources: OFHEO, Torto Wheaton Research

Home Prices within South California

$100

$150

$200

$250

$300

$350

$400

77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02

Los Angeles Orange County Riverside Ventura San Diego


Office Rents Move together Cyclically but not Office Rents Move together Cyclically but not

Forecast

15

20

25

30

35

40

1980

1981

1982

1983

1985

1986

1987

1988

1990

1991

1992

1993

1995

1996

1997

1998

2000

2001

2002

2003

2005

Los Angeles Orange County Ventura County Riverside San Diego

TW Rent Index, 2003$ per sqft

always secularlyalways secularly


Closely Correlated Industrial Rent

Forecast

4.00

5.00

6.00

7.00

8.00

9.00

10.00

1980

1981

1983

1984

1986

1987

1989

1990

1992

1993

1995

1996

1998

1999

2001

2002

2004

2005

Los Angeles Orange County Ventura County Riverside San Diego

Movements: few secular differencesMovements: few secular differencesTW Rent Index, 2003$ per sqft


20

25

30

35

40

45

50

55

60

65

1980

1981

1982

1983

1985

1986

1987

1988

1990

1991

1992

1993

1995

1996

1997

1998

2000

2001

Suburban Markets Manhattan

Manhattan Office Rents vs. NJ and Conn. Suburbs

TW Index, $2002 per sqft


10

15

20

25

30

35

40

45

50

1980

1981

1982

1983

1985

1986

1987

1988

1990

1991

1992

1993

1995

1996

1997

1998

2000

2001

Northern New Jersey Long Island Stamford Westchester

Office Suburban Rents in DetailTW Index, $2002 per sqft


Prices and Development• Prices bring forth development: of any urban land

use..• Development occurs so as to maximize the

residual value between: Price-capital costs (construction).

• This residual is “land value”. Development maximizes land value.

• Land Development is a natural real option: incur heavy capital costs to realize an income stream –or- wait (to do the same later) ?


What is a real Estate Market?• Within “markets” all properties should

move together: high substitutability, easy mobility.

• Between markets there exists frictions, transportation costs, immobility of resources and low substitutability.

• MSA as “market”? CMSA?

MIT Center for Real EstateBetween MarketsBetween Markets –– there can be huge differences in there can be huge differences in

both long term growth and cyclic riskboth long term growth and cyclic risk

0

5 0

1 0 0

1 5 0

2 0 0

2 5 0

3 0 0

3 5 0

1 9 8 0 1 9 8 5 1 9 9 0 1 9 9 5 2 0 0 0 2 0 0 5

B o s ton

L osA n ge lesCh ic a go

Na tio n

Da lla s

1 9 8 0 = 1 0 0 (C o n s ta n t $ 2 0 0 5 )


Metropolitan Housing Markets can even move independently

FIGURE 5. Repeat Sale House Price Indices for Selected "new" Cities: 1975-1999 (constant $)

50

70

90

110

130

150

170

190

210

230

250

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

Year

Hou

se P

rice

Atlanta Dennver Houston Los Angeles Phoenix


Although sometimes they are subject to a common economy wide Shock

50

70

90

110

130

150

170

190

210

230

250

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

Year

Hou

se P

rice

Boston Chicago New York Sanfrancisco Washington D.C.

FIGURE 4. Repeat Sale House Price Indices for Selected "Traditional" Cities: 1975-1999 (constant $)

11.433j / 15.021j real estate economics - mit - massachusetts

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